Looming Retirement Crisis — 401(k) Plan Problems Not A Joking Matter

Some say the 401(k) movement is a failure.

Editor’s note: Contributing columnist, Steve Nicklas, expresses his views and insight on various topics in Marketplace.

— Steve’s Marketplace —

In a declining stock market (like we’re experiencing now), participants in company-sponsored 401(k) plans fall behind in preparing for retirement. Some joke their plan resembles a 201(k) after heavy losses. 

But it’s no joking matter. A retirement crisis is looming in the U.S. 

Since the late 1970s, company-funded retirement plans offering a defined pension have been replaced with employee-funded 401(k) plans. More than half of the companies in the U.S. offer a 401(k) or other employee-funded plan (i.e. Simple IRAs). 

In a 401(k), the contributions are defined by the employee. The final tally from what they contribute and how they invest is determined solely by them. Even though employers often match some of the contributions, the final result is potentially not suitable for a secure retirement. 

Companies receive tax breaks for offering retirement plans for their employees. And employees can avoid taxes on contributions into most plans (until they withdraw them later). 

These are powerful forces. In addition, employer matches are essentially free money. Even though employer contributions may be frozen for a period of time, they nonetheless enhance the returns. 

Participants who regularly contribute to their retirement accounts, whether a 401(k) in the private sector or 401(a) or 403(b) in the public arena, also benefit from a compounding effect. And when the price of an investment declines, more shares can be purchased at lower prices. 

In addition, 401(k) plans are portable. When an employee leaves one job for another, he or she can usually roll the balance into the new company plan. Or direct rollovers into Individual Retirement Accounts (IRAs) are also possible. 

And for those dissatisfied with poor investment options or fees in their 401(k) plan, an in-service withdrawal can sometimes be done into an IRA. This can occur while someone still works for the employer and still participates in the 401(k) plan. 

Investor behavior is another problem. Studies demonstrate that a typical investor will liquidate investments when the stock market declines, and jump back in after a rebound. In other words, they buy when prices are high, and sell when they are low. 

With older retirement plans, employees earn a pension after so many years of service. And they know how much their pension will be. However, there is no guarantee within the 401(k) framework.  

Regardless, the proliferation of 401(k)s is dwarfing traditional pension plans (or defined benefit plans). There are 600,000 401(k) plans in the U.S., with 60 million participants and $4.8 trillion in assets. While there are few pension plans in the private sector, there are still plenty in the public/government arena. 

Vanguard is a major player in the 401(k) space. In a recent survey, Vanguard reports the median balance in a 401(k) is $35,000. And it hasn’t really grown since 2012, despite a roaring stock market.  

Daniel Halperin, a professor at Harvard Law School, was a senior official at the Treasury Department when 401(k)s were developed. “Nobody thought they were going to take over the world,” Halperin says. 

“The 401(k) plan changed two things,” Halperin says. “You could choose not to participate. And you chose your own investments, which a lot of people, I think, screw up.” 

Some say the 401(k) movement is a failure. And the joke is on us. 

____Steve Nicklas is a financial adviser with a national brokerage firm who lives and works on Amelia Island. He is also an award-winning columnist. His columns also regularly appear in several weekly newspapers in North Florida and in Southeast Georgia, and on his website at SteveNicklasMarketplace.com. He has published a book, “All About Money,” of his favorite columns from the past 20 years. The book is available on Amazon. He can be reached at 904-753-0236 or at [email protected].